The future of the euro

As Spain is bailed out, with some mystery over who exactly is going to be footing the bill, we are forced to focus once again on the existential threat facing the euro: will the teenage currency make it through adolescence? Are these just growing pains or the “beginning of the end”?

The possible answers, the two choices facing Europe as George Soros calls them, will be decided pretty soon. In fact the decision on how the Spanish bank bailout is financed will give a very good indication of which force will be in the driver’s seat: If the European Central Bank pays (be it through buying ESM bonds or some similar move) this will hasten the eventual break-up of the eurozone as Germans revolt against a Weimar dejà vu. If the euro-core pays (mostly Germany), be it through direct fund transfers to the ESM or EFSF, or by explicitly guaranteeing bond issues and thus impairing their own credit to “lend” credibility and cheaper financing to the periphery, it will signal the full commitment of Germany to the survival of the eurozone in its existing form. This will come with strict fiscal policy guidelines for the bailees, and lead to rapid advances in eurozone fiscal union.

The debate as to whether euro survival would be a good thing is raging within the Austrian economics community. Of course we know that Keynesians would love to love the euro, if only the Germans would allow the ECB to print like the Fed, providing liquidity to the periphery and removing the cruel “golden fetters” of fiscal discipline. George Soros, Paul Krugman and others make continual calls for just such a “weak euro” policy, alongside demands for an end to “austerity” in the eurozone periphery and more government stimulus programmes.

Failing that, a euro exit for periphery countries that would allow them to print liras, drachmas and pesetas to their hearts’ content is assumed by most economists to be the next best thing. This latter solution is now conventional wisdom among British and American monetarists, who unlike their left-inclined Keynesian brethren are more partially disposed to national sovereignty, and in the vast majority of cases, opponents of EU integration. They are also fervent believers in an elastic money supply and the benefits of external devaluation as a means of restoring countries’ economic competitiveness.

In contrast, many Austrian economists are conflicted. On the one hand, they admire the fact that the euro is forcing irresponsible governments to cut profligate spending. Absent the euro, and the Greek, Spanish and Italian government would simply resort to money printing as a means of numbing the pain – with all the unintended consequences and malinvestments that Austrians identify as the pitfalls associated with this “solution”.

In his excellent essay In Defence of the Euro, Jesús Huerta de Soto argues – with many caveats of course – that as long as a German mentality rules at the ECB and the central banks refuses to print to bail everyone out, or at least forces them to negotiate each particular instance of money printing, the euro can behave as a gold standard “proxy”. This forces reforms on politicians and markets; reforms that without the euro would have never been carried out, given the easy devaluation alternative associated with monetary nationalism. Huerta de Soto argues that internal devaluation, such as the liquidation of malinvestments and reduction of salaries, will be carried out in an asymmetric fashion – thus improving efficiency, instead of being papered over in the symmetric economy-wide adjustment that external devaluation brings.

Philipp Bagus’s book The Tragedy of the Euro provides Austrian counterarguments to Huerta de Soto’s position. Bagus argues that moral hazard permeates the eurozone as it is currently structured. Not just during the boom years in which the fiscal profligacy of many periphery countries was exaggerated by easy credit, but also in the lean years, when the calls for bailouts and money printing will always be louder than prudence. Hard-money German central bankers will be driven out by political pressure (check and check!) and in a perfect example of Hayek’s dictum that “the worst rise to the top” we will end up with easy-money central bankers who are happy to bend to political demands for more “stimulus” and “liquidity”. Eventually, given the exponential nature of debt-based fiat money, hyperinflation will occur.

The Austrian school debate over the euro is actually a new iteration of the very old classical liberal centralism vs. decentralisation argument. In short: is it better to impose discipline and freedom from the top down? If balanced budgets remain beyond the intellectual or practical capacity of Spanish and Italian politicians, wouldn’t it be better to have it forced on them by technocrats in Brussels?

This argument falls down the moment you have an easy-money Italian central banker in Frankfurt and a socialist sitting in the Élysée Palace in Paris. And what happens if Angela Merkel is replaced by a Social Democrat at the next German federal election? Instead of relative discipline, we might soon see Brussels and the ECB as well disposed to deficit financing as Ben Bernanke’s Federal Reserve has been. Then we will have nowhere to run.

At least in a Europe with 25 or 30 competing currencies we have a chance, albeit small, of one or two countries doing the right thing. It takes only one to institute a gold standard, or at least a solid, D-Mark-like “hard” fiat currency, for the benefits to shine like a beacon and eventually result in other countries following the example. It took a Hong Kong to make China capitalist, but believe it or not, Brussels was not necessary for European free trade. The great political and social advances in history do not come about by consensus. Our best chance is someone leading by example.

Of course if the euro survives the US dollar, it might prove enough of a shock to eurozone leaders to make them reject fiat, the same way that the collapse of the Continental Dollar led Jefferson and the American founding fathers to embrace gold and silver. However, though the dollar might be currently ahead of the euro in the race to the cliff’s edge, the euro is catching up to the dollar rapidly and is likely to overtake as soon as Germany takes its foot off the breaks. Those who purchase gold now may end up thanking their lucky stars.

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